Prudential & Norwich Union With-Profits Policyholders in Uproar Over Use of Funds

NCD News: Prudential & Norwich Union Insurance - 25.06.08

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Prudential & Norwich Union With-Profits Policyholders in Uproar Over Use of Funds: Insurance plans traditionally present one of the most conservative and stable investments available. They have two primary benefits: they protect policyholders and also, under some plans, offer an opportunity for relatively stable earnings. With-profits plans began as a way to satisfy both the working capital (cash for regular operations) needs of the insurer whilst paying regular earnings to policyholders. Under a with-profits plan, the insurer holds back some of the monies due policyholders during financial "good times" and keeps these to pay out to policyholders when times are not so good. The policyholder gets a steady stream of income regardless of economic conditions, while the insurer keeps extra cash on hand.

However, as an insurer through this method builds up cash reserves beyond what it most likely will have to pay out in coverage (its "realistic liabilities"), it faces a choice as to how these surpluses will be spent. These surpluses, called inherited estates, can be used only according to Financial Supervisory Authority (FSA) guidelines. If they are paid out, these guidelines require 90% to go to policyholders with the remainder available to shareholders. The FSA's guidelines appear to be equitable and clear on this point.

But what if the inherited estates (the "surplus cash") of the insurer is not paid out? Does an insurer have unlimited rights to use them as it sees fit? This is where Prudential and Aviva (previously Norwich Union) - two insurers who dominate the with-profits instruments holding £13 billion between them according to Citywire.co.uk - have caused a controversy. Inherited estates have been used by the two insurers to pay tax liabilities, compensate for mis-selling, expand business operations and cover other costs that many feel should have been borne by shareholders, not policyholders. Parliament's Treasury Committee noted that Prudential alone spent over £1.6 billion in inherited estates to cover mis-selling - a waste or clear bias in favor of shareholders.

A second issue involved is reattribution. This is a plan to compensate policyholders through the inherited estates not by paying them out through the aforementioned 90-10 formula, but by paying policyholders "windfalls" in cash in return for them giving up their rights to the inherited estates. In essence, policyholders get cash today in return for giving up cash tomorrow. This can only be done through negotiations with policyholder advocates such as Clare Spottiswoode (in Aviva's case). Aviva and Ms Spottiswoode seem to be in the final phases of such a deal as this goes to print. Thisismoney.co.uk forecasts any Aviva windfalls would be between £600 and £3,000 per policyholder.

Prudential is another matter entirely. It also at one point seemed ready to announce windfalls totaling £8.7 billion. At the close of June, however, Prudential stated there would be no windfalls at all. Prudential policyholders have thus truly been roughly handled: Prudential has used "their profits" (the inherited estates) for its own business operations and mistakes. Then, policyholders were teased with the prospects of windfalls, only to see them withdrawn. Some of the worst cynics in the field even suggest that Prudential canceled the proposed windfalls in order to "lock-in" current policyholders through the hope of future windfalls. Not all shareholders agree with the idea of reattribution, either, since they are costly. Thisismoney estimates that a Prudential windfall would have averaged £1,000 per policyholder.

However the matter turns out, a central problem remains: how may the inherited estates be used? Is the technique of a reattribution truly in the interests of the policyholders, or a sneaky attempt to deprive them of much larger potential monies later in the form of the 90-10 split FSA regulations on inherited estates payouts require?

MPs on the Treasury Committee were clearly doubtful about how the insurers were handling the inherited states - and likewise doubtful (if not scathing) on the FSA's handling of these problems.

The market may have the final say over the long term, however. With-profits plans are steadily declining in popularity among UK policyholders. According to the Treasury Committee, new with-profits plans totaled £4.1 billion in 1985 but only £285 million in 2005. One reason for policyholders making the switch appears to be the fact that non-with-profits insurers are more transparent. †